Special Seminar on "'Partial' Sovereign Restructurings and Their Implications”:How a Ratings Agency Brings a Country Out of Default"

EMTA Panel Explores Implications of Partial Sovereign RestructuringsOn June 7, EMTA initiated a series of investor-oriented panel presentations designed to explore issues of relevance to investors in today’s Emerging Markets and to promote greater transparency and efficiency in the EM trading and investment marketplace. While the initial panel presentation focused on the Implications of Partial Sovereign Restructurings, presentations later this year in NYC and London are expected to explore GDP Instruments, Enforcement Under the FSIA, Does Enforceability Matter?, Whither the Restructuring Process?, and the Role of the Official Sector.

EMTA Executive Director Michael Chamberlin introduced the June 7 program by contrasting the commercial bank restructurings of the 1980’s and early 1990’s with the recent Argentine bond restructuring. In particular, he noted that while earlier restructurings had generally included a critical mass of 95% or more of the applicable debt, Argentina’s restructuring, while relieving a substantial debt burden, had left outstanding about $20 billion in defaulted claims, with a substantial amount of unsatisfied court judgments. This distinction alone, and the continuing legal risks faced by Argentina, raised the question of whether Argentina would be able to leave its debt problems behind and return to the voluntary markets. This in turn raised questions about whether the existing legal framework for enforcing sovereign claims and restructuring them promoted the efficient functioning of the market. Chamberlin concluded his introduction by noting that EMTA’s purpose in presenting the panel, which was intended to be the first of a series of investor-oriented panel presentations by EMTA, was to explore what, if anything, had been learned in recent years that could be used to strengthen the EM marketplace and make it more transparent and efficient.

Lisa Schineller of Standard & Poor’s initiated the panel discussion by describing S&P’s approach toward bringing Argentina out of default and explaining that ratings were intended to be forward-looking appraisals of the country’s capacity and willingness to meet its obligations. Though Argentina’s untendered bonds continue to be rated D, Argentina generally was taken out of SD (initially to B- in June 2005, and more recently to B) because it was no longer meaningful to focus on the default. Although Argentina’s recent track record does bear on the agency’s appraisal of willingness to pay, and continuing litigation risk was taken into consideration (the untendered bonds effectively being treated as a contingent liability), Argentina’s current rating reflects a judgment that such risks had abated somewhat, and that even if collection efforts were successful, Argentina’s public finances were unlikely to be disrupted and it had sufficient resources to meet its obligations. When asked if Argentina would have been rated higher had it dealt with the holdout creditors, she said maybe not. Asked if there were any qualitative factors that would effectively impose a ceiling on Argentina’s rating should its economy continue to improve, she responded that it was premature to discuss that as a possibility. In this regard, Schineller noted that in the long history of sovereign debt default and restructuring, partial or complete repudiation was not without precedent.

Asked if he believed that Argentina faced a significant litigation risk from its holdout creditors, Professor Hal Scott from Harvard replied that he wished they did, but realistically he thought they did not. He explained that this was due to a number of factors, the most important being that the current legal framework was not very friendly to creditors. Among other things, he pointed out the irony that the US legal system creates very strong contractual rights, but then makes it very difficult for creditors to enforce them. In addition, he noted that courts have shown an unwillingness to upset the restructuring ‘applecart’, especially when, as recently, creditor governments (such as the US) have intervened on the side of the debtor countries.

Commenting on the apparent trend of debtor countries like Argentina structuring their new issues as local markets transactions, in part to shield them from legal actions, Professor Scott remarked that Argentina law didn’t look so bad now in view of recent developments under NY law. He concluded by expressing his view that the lack of a significant litigation risk for Argentina was undesirable, mainly because he thought that, while not free from doubt, on balance the presence of holdout creditors with significant enforcement rights imposed a form of discipline on debtors and tended to ‘improve the deal’ for the benefit of all creditors. It was unclear to him whether or not the market could itself impose much in the way of discipline in the absence of stronger creditor enforcement rights, particularly given the prevailing investment climate in which historically low interest rate levels had encouraged such massive inflows into the EM asset class.

Michael Straus of Straus & Boies, a long-time advocate of stronger creditor rights, pointed out that one of the original purposes of the FSIA was to de-politicize the granting of immunity to foreign sovereigns in the US courts and thereby make the judicial process more transparent and objective. Previously, the courts often relied on positions taken by the State Department, which tended to inject an element of arbitrariness into judicial proceedings. Unfortunately in his view, recent reliance by US courts on amicus curiae briefs filed by the US government tended to undo the more objective approach that the FSIA was designed to establish.

Whitney Debevoise of Arnold & Porter, who has a well-established practice of representing major sovereigns, noted that those concerned about the current state of creditor rights in the US courts needed to look at the broader overall picture of how current enforcement rights compare with the situation that existed before the enactment of the FSIA, as well as enforcement possibilities in other countries, such as Germany. He said that he had ‘crocodile tears’ for creditors who knew full well before they made their investments what the enforcement limitations were. Comparing the legal framework for sovereigns with domestic corporate debtors, he also expressed his view that there were insufficient incentives or mechanisms for collective action by creditors to negotiate solutions.

Several panelists, including Michael Straus and Professor Scott, argued in favor of a new approach toward the allocation of payments when a sovereign went into default, one that imposed an obligation on the sovereign to make payments proportionally to all creditors. Such an approach might come from a newly designed pari passu clause, new legislation, or a more expansive reading of the existing clause along the lines of the interpretation that had for a time been applied in the Belgian courts. Mark Rosenberg of Sullivan & Cromwell noted that even the broadest interpretation would mean that a creditor seizing funds receives only a proportional share of the seized assets and expressed doubt that any new legislation would be effective with respect to bond offerings made before the date of the legislation. Several other panelists, as well as several members of the audience, challenged the more expansive interpretation of the pari passu clause as unwarranted, and also questioned whether a more expansive clause would be workable. While agreeing to disagree in various respects, most panelists seemed to concur that the current clauses, as traditionally interpreted, were not particularly clear or meaningful. Asked from the floor why the current clauses had not been changed, several panelists observed that some had been changed, while others had not, reflecting in part that there was a lack of consensus about whether or not such changes were desirable and also that there were not clear mechanisms for making such changes in bond documentation.

Several panelists, including Michael Straus, Mark Rosenberg and Jim Kerr, reviewed various developments in the application of the FSIA, concluding that recent interpretations of what was commercial property eligible for attachment in the US had imposed ‘high hurdles’ to creditors seeking the enforcement of judgments.

The panel concluded with some discussion of the appropriate role of the official sector, and particularly the IMF, in resolving sovereign crises. Whitney Debevoise remarked that one apparent difficulty in Argentina had been that the official sector had not correctly signaled what level of debt relief was required and what level of creditor acceptance was necessary. Other panelists agreed, but an IMF representative noted from the floor that the IMF, which has recently been criticized by Argentina for its handling of the crisis, was constrained by the lack of an existing program with Argentina, and was therefore not able to exercise much influence in resolving the crisis. Professor Scott noted that early on in the crisis the IMF had sufficient leverage, but had apparently declined or been unable to exert it.

Summarizing the discussion, Michael Chamberlin noted that, just as the favorable economic environment had bolstered the performance of Argentina’s economy, it may also have made investors generally more tolerant of the apparent erosion of creditor rights. Perhaps with the passing of time, and changes in the current economic climate, the market might become more discriminating and inclined to impose some form of discipline on debtor conduct. In any event, the panel had succeeded in covering a wide range of issues relating to the balancing of debtor and creditor rights that would merit further review in subsequent EMTA programs.